The default doomsday scenario

Those are some of the terms economists — not just politicians — are using to describe a US government default, which could happen if Congress doesn’t raise the debt ceiling by Oct. 17. Missing that deadline could trigger a chain of events strong enough to push the country back into recession, the ramifications of which economists say would last years.

“It’s a very long, dark tunnel with a train headed our way,” said Lynn Reaser, chief economist at Point Loma Nazarene University.

Or is it? Americans don’t know for sure because a US default hasn’t ever happened.

But just the prospect of a default is causing stock market turmoil and economic slowing. It’s a near repeat of 2011, when Congress came to the brink of default, only to come to an agreement the day before the deadline.

The U.S. Treasury reports it took months to recover from the damage done to the economy from the political brinkmanship in 2011.

“The financial market stress that developed in August of 2011 persisted into 2012 even though Congress raised the debt ceiling prior to the exhaustion of extraordinary measures,” says the report, released last week.

For example, the S&P 500 dropped 17 percent, and didn’t recover to its 2011 first-half average until 2012; consumer confidence fell 22 percent, and the 30-year mortgage rate spread jumped by 0.7 percent.

This year, the Treasury will have $30 billion left to pay its bills if the debt ceiling isn’t raised, but that money won’t last long. Funds may be exhausted by the end October, and there won’t be enough money to pay the $67 billion in payments due Nov. 1. The government reached its $16.7 trillion debt limit in May. Since then, it has been using “extraordinary measures” such as suspending U.S. investments in federal employee trust funds to create about $300 billion in additional borrowing room.

Should Congress not vote to raise the debt ceiling, the ensuing problem would be two fold: Interest rates would rise and billions of dollars would no longer flow into the economy through government spending.

“It starts in from the government and it spreads into the private sector,” said Esmael Adibi, economist at Chapman University. “Everything is interconnected.”

Here’s a closer look at the two major issues:

• Rates on the 10-year U.S. Treasury note would rise. The interest rate on the government bond is viewed as a floor for all other investments, meaning if that goes up, so do mortgage, auto loan and credit card rates. That’s because Treasury notes are historically risk free and at no time has the U.S. not made good on its debt. A 10-year note yields 2.66 percent, but investors would demand a higher return if they felt their money wasn’t as secure.

Adibi noted that when Greece faced a default, it had to borrow at around 26 percent interest. That wouldn’t happen to U.S. Treasury notes, he said, but they still could increase to perhaps 4 percent.

“That is going to cause a significant jump in mortgage rates and it’s going to derail the housing market,” he said.

Government spending would decline by about 20 percent, creating a ripple effect throughout the public and private sector.

President Obama’s original 2014 budget proposed to run at a $744 billion deficit, on top of $3.03 trillion in income. If the government can’t borrow $744 billion, that’s $62 billion out of the economy each month.

“If they cut that much, that’s going to be recessionary,” Adibi said. “Think of the trickle-down effect. The defense department has contracts to buy some stuff from a private company. They’re not going to buy it because they have to cut it. That private company producing uniforms or communications, they’re going to have to lay off workers.”

San Diegans would especially feel the cuts because its defense-laden economy accounted for $24.6 billion of direct spending in fiscal 2013, says a report by the San Diego Military Advisory Council. The report found the military sector to be responsible for about a fifth of the region’s payroll jobs, or 302,000.

Should a default take place, Alan Gin, economist at the University of San Diego, said the most catastrophic event would be a downgrade in the U.S. credit rating. That happened in 2011, even without a default.

President Obama signed the Budget Control Act into law on Aug. 2, a day before the U.S. was to reach its limit. Three days later, S&P downgraded the U.S. credit rating from AAA to AA-plus. The Dow Jones dropped 630 points the next business day.

Adibi said he believes the Treasury would be able to prioritize paying interest and principal on the loans, Social Security and Medicare payments first. He said the economy could withstand the hiccup if the impasse goes a week. If it lasts, it would become catastrophic, he said. But, Adibi said, the psychological damage to investors would already be done because the U.S. proved it was capable of the previously unthinkable default.

“If you do something once, it means you could it again,” he said. “The fact that we broke our promises, that lack of confidence has a price and cost.”